The term capital market refers to the network of procedures and institutions that facilitate transactions of long-term financial products. These are usually sold from a corporation or government to investors, or traded between investors. Several different types of capital market products exist, various kinds of bonds and stocks, sometimes called equity securities. In the U.S., companies and investors may also store funds in U.S. Treasury bill bonds and federal agency securities.
Two important elements of the capital market are organized security exchanges and over-the-counter markets. Organized security exchanges are physical places where capital market products are traded. Any kind of trading arrangement that doesn’t happen at an organized security exchange happens at over-the-counter markets. Financial managers have several payment arrangement options when buying and selling securities on these markets, including checks, automatic transfers, wire transfers, and cash accounts.
Stocks are some of the most popular capital market products. There are two basic types of stock, common and preferred. Common stocks are ownership shares of a corporation sold on the capital market to investors. In return for the investment, stocks pay shareholder’s dividends that vary in amount depending on the overall financial health of the company. Stocks likely to pay higher dividends are traded at higher prices.
Speculation on the financial health of a company shifts its stock price, which leads to the up-and-down trading prices common to many modern capital markets. Preferred stocks may not be sold publicly, and unlike common stock, preferred stocks have fixed dividend payment amounts that don’t vary depending on the corporation’s standing. Non-payment of due dividends does not force bankruptcy for either common or preferred stocks.
Compared to stocks, bonds can be much less volatile capital market products. Bonds are long-term promissory notes held by lenders. Often, bonds commit the payment interest on the amount borrowed and, usually, an eventual repayment of the principle debt. Some types of bonds include debentures, mortgage bonds, and junk bonds. Debenture is a blanket term for unsecured bonds.
When a company issues a second round of bonds before repaying the first, these debts are called subordinated debentures. These are riskier than regular bonds because the issuing company holds more debt, but the interest payments are usually higher. Mortgages are bonds secured by real property, which makes them generally regarded as less risky than debentures. Junk bonds are debt products that yield high interest, but have a low probability for full repayment of the principle debt.